Financial Markets, Financial Dependence, and the Allocation of Capital

Abstract

We explore one specific channel through which finance promotes growth: the allocation of capital. Using international industrial data, we find that countries with developed financial markets invest more in growing industries, and pull out more funds of declining ones. Most interestingly, this pattern is more eminent for those industries more dependent on external financing. Various robustness checks show that the results are not driven by reverse causality, omitted variables, specific countries or industries.

Keywords: Capital allocation, Financial development, Financial dependence, Investment

JEL Classification: G15, G31, D92